The legacy of the US debt ceiling spectacle will live on

I came across Pimco founder and legendary bond investor Bill Gross’s views on the US deficit agreement a day after penning my own blog on the theme. He too, it seems, feels that there has been immense and lasting damage done to US credibility by this all-too-public display of a dysfunctional government in action. Key for Gross is the fact that, as he puts it:

“The whole world was watching, and what they saw was a dysfunctional government taking its country to the financial precipice and backing off at the very last moment.”

No one would invest in a company whose Board behaved like that and while most people understand that politics is a lot messier than your average Boardroom, bond investors get spooked when countries behave like that. They get even more spooked when it occurs to them that the country concerned is up to its ears in debt, with the tide rising all the time.

Scratching the surface

For Gross, the problem with the debt ceiling “agreement” is that it only purports to be an agreement about debt reduction as the price of raising the debt ceiling. In reality the deal agreed by Democrats and Republicans barely scratches the surface of the Budget’s $1.5 trillion of debt. As Gross points out, “The US Office of Management and Budget (OMB) estimates that future deficits will be reduced (by the proposed cuts) at most by 0.5%.”

The problem, he notes, is not so much the $1.5 trillion deficit in the present Budget, or even the nearly $10 trillion of outstanding Treasury debt. It is the $60 trillion of social benefits the US has promised to its citizens in the form of Medicare, Medicaid and pensions in the years to come – promises that are way outside its power to keep, but which revolve around areas that US voters will not tolerate much mucking about with. Any US politician who tries to run on a ticket of cutting Medicare and pensions may as well stay home and grow roses, because he or she is not going to be making any victory speeches come election night.

The only people who can make serious inroads into America’s debt mountain are the politicians already in office, and with elections coming up in the not too distant future, none of them are likely to be up for the job if it means hacking large chunks off Medicare provision for the elderly and the infirm. That leaves America in the position of having to kick the can down the road yet again. But this time, after the debt ceiling fandango, investors can see only too clearly where that road leads. Expect the markets to be in turmoil for a while yet…

Outside the US

Of course, promising more by way of social benefits than the country can afford is not a uniquely American problem. Although few are as indebted as the US, developed economies across the world have, with the cold light of hindsight, built up more in the way of social benefit promises than they have cash to pay for. In that sense, they are all rubbing shoulders with Greece. These social benefit promises are certainly not commensurate with the meagre rates of real GDP growth being achieved by advanced economies. Therefore it follows that sooner or later the harsh truth is going to have to be faced, namely that the social benefit pledge the governments of advanced economies have made to their citizens are proving unaffordable. The only choice, ultimately, is whether these pledges are dialled back before or after a catastrophic debt default – one way or another, dialled back they will have to be. Which does not bode well for your old age or mine…